Will Naysayers See the Pain?

By Ed Paisley
Posted on September 30, 2008, 9:00 am

U.S. Treasury Secretary Henry Paulson and President George W. Bush yesterday failed to convince a majority of their own party in Congress that the consequences of failing to pass their $700 billion financial rescue package could be catastrophic for the U.S. economy. The American people over the next few days will catch a glimpse of the consequences in financial markets, at their hometown banks, and at their jobs, but should congressional inaction persist we may not experience the full brunt for a month or more.

That’s why these next few days will be so telling. If those who opposed the rescue package in Congress do not feel responsible for the leading edge of the problems they have allowed to grow—as prices fall, borrowing costs rise, and more and more small- to medium-sized companies and financial institutions are unable to access credit—then they are unlikely to change their minds about the bailout plan. If their constituents do not get antsy as the problems of Wall Street start to spread to the companies they work for and to their own access to credit, and they do not demand action—no action may be forthcoming.

Will the financial markets spook enough of the dissenters to change their vote on the bill, which fell only 12 votes shy of passage? That probably depends most immediately on how dramatic the reaction is in the commercial paper market, which was largely done with trading yesterday before the bailout bill went down to defeat. This vital credit marketplace—where companies tap short-term credit to smooth out their cash flow needs to make payroll and pay suppliers in a timely fashion—could react sharply today. This morning’s record high for the benchmark London Interbank Offer Rate—the rate at which banks lend to each other—is not a promising sign.

Already the two biggest providers of short-term credit to restaurant franchises, GE Capital and a unit of Bank of America, are now out of that lending marketplace. GE Capital’s parent, triple A-rated General Electric, is paying dearly to borrow itself in the commercial paper market, as are the majority of other big companies. Some, such as General Motors Corp., can’t borrow at all. Without access to credit or access only to costly credit, these and other companies will have no alternative than to cut back on corporate spending, cut jobs, and stop investing in future product development.

Those consequences however, may not be evident in the news over the next few days. President Bush and Secretary Paulson will have to point to the locked-up credit markets to make the case that the crisis is growing. Let’s hope they are more persuasive this time.

But more bank failures could focus minds of Capitol Hill over the next few days. After Wachovia collapsed in the arms of Citigroup—the most recent but by no means the last bank failure in the United States this year—the share price of many regional banks took a pummeling yesterday. Worryingly, depositors are reacting to falling stock prices by pulling out their money. More bank runs over the next few days in communities across the country could spark panic to change some of their votes.

“It’s-a-Wonderful-Life” banking doesn’t really exist anymore, when banks took in deposits, made loans from those deposits, and earned a reasonable profit on the interest. Today, even deposit-heavy commercial banks borrow in the markets themselves to raise money to lend to borrowers and in turn sell those loans to institutional investors worldwide—earning vastly higher profits in the process. Unfortunately, after being severely burned after purchasing soon-to-be troubled residential and commercial mortgage-backed securities, these investors are not buying any debt, be it credit card, auto loans, or student loans that banks and other financiers want to package and sell to them. And the banks themselves can’t borrow except at extremely high rates of interest to make those loans in the first place. The consequence: a severe contraction in the availability of credit for cars, college, or retail purchases.

Yesterday’s failure to pass legislation didn’t cause the economic problems we face now. That responsibly falls squarely with the Bush administration and their conservative enablers, who felt that government oversight of the financial sector was inappropriate and therefore got us into this situation. They are also responsible for the failure to address the stagnant and falling wages and weak job growth of the last eight years. But the hole can still get deeper. The consequences will start being evident today in the reaction of financial markets to the vote against the president’s bailout package.

Will the “no-voters” fathom the consequences? On that hinges the severity of recession.

Ed Paisley is Vice President of Editorial at the Center for American Progress.